Macro and Micro Consequences of When A Recession Begins
In a recession, timing plays an absolutely vital part at the macro level. Much of the debate about when the current recession will end is related to when it actually began. The “reality” of a recession — as defined by the numbers as opposed to perception or sentiment — is subject to much variation, interpretation and retroactive restating. As we continue lower and deeper into the current recession, and as the various governments (USA, Germany, France, Spain, UK…) worsen their economic forecasts, there is growing evidence to believe that the recession began earlier than previously thought. And, at the very same time, the [US] stock market has started to show signs of life and confidence metres are bouncing off the very low levels.
Yet, if the duration of the recession is related to the timing of the start on a macro level, there is also an interesting phenomenon of timing on the micro level. When the existence — or indeed the potential existence — of the recession sinks in, people and companies get into battle stations. Common wisdom says that the companies that react most quickly (cutting costs and focusing on the essential business drivers, etc.) are those likely to do best. This is especially true these days because, over the last 25 years, the recessions have tended to be rather short. Three of the last four recessions in the US lasted on average 7 months (the school book definition states a minimum of two quarters is necessary). The other one, 1981-1982, lasted 16 months. (See here A History of Recessions from CNBC).
There is much written about how companies ought to respond. I am not going to add to that catalogue. The point that I want to raise here is the importance of the month(s) of the year when the recession is perceived as starting (as opposed to when it is post-factum marked as officially beginning). The nature of the timing is more than psychological. If the moment when people perceive the recession is at the end of the year, as opposed to the beginning or the middle of a year, there are logical consequences as to how the following year will be planned and budgeted.
The effects are almost mechanical. Here is a typical scenario if the recession is identified in the autumn (i.e. the fall, the last quarter of the year). Budgets for the new year are created in an environment of uncertainty. According to the dose of reality, for the companies who have recognized the recession, contingency reserves are bolstered, hiring freezes are imposed, costs are constrained and forecasts are trimmed. Heading into the first months of the calendar year (assuming a calendar fiscal year), the company faces comparisons against the healthier first quarter of the year before. And, if the effects of the recession are under-evaluated, the cutting of costs is accelerated and marketing budgets are further trimmed. However, since much of the first half of the year’s expenses are already engaged, investments to drive the second half of the year are most affected. With forecasts falling, unit volume decreases putting pressure on cost of goods further crimping profits. Quite the vicious circle and one that suggests that the quicker a company realizes and reacts to the recession — to take the painful decisions quickly — the more prepared that company will be to see itself through.
On the other hand, if the recession were to be identified in the spring, the budget of the current year is put out of commission. Companies have to scramble into battle stations and start to cut back according to the speed at which they identify the challenges. As results deteriorate, the planning phase in the autumn for the following year’s budget is also very precarious, but at least it is created in fuller knowledge of the poor macroeconomic environment.
Looking at the 2001 recession, the curious aspect was that, only with 9/11 did economists start clarioning about recession. It turned out that the recession began in March 2001 and ended in November. However, companies only started to react truly after September 11th. As a result, budgets for 2002 were tossed up and around like straw in a hurricane. And yet, the economy was actually rebounding as the new year rolled in.
It strikes me that, even if the length and depth of the recession ends up being longer than usual, the way a recession is experienced does vary according to the timing in the year of the perceived beginning. I would be curious to know if studies have ever been done to see if companies with non calendar year fiscal years have a markedly different experience to those who have calendar year fiscal years. What do you think?
If, as they say, timing is everything, does it make any material difference when in the year people identify that a recession has begun?